The Tax Question Behind Your Pennsylvania Settlement Money
When you finally reach and receive a personal injury settlement, you probably feel and think many different things, from relief or excitement to deciding how best to apply the settlement to the aspects of your life hit hardest by the injury. What you may not be thinking about are taxes. Residents of Pennsylvania who’ve experienced a personal injury frequently wonder whether they’ll need to pay taxes on their settlement. It’s a reasonable concern, especially given the complexities of state and federal tax laws. Understanding how these rules apply can help ensure you make informed decisions about your settlement.
A Closer Look at Tax-Exempt Personal Injury Settlements in PA
In the majority of personal injury cases, settlement receivers can expect that money to be untaxable. Federal laws under Section 104 of the Internal Revenue Code (IRC) and Pennsylvania state laws recognize settlements as tax-exempt in specific circumstances. The reasoning is simple: compensation for physical injuries or for an illness suffered is intended to be restorative rather than just taken as income. It’s there to make you whole again after you’ve suffered a tragic deal of harm––not to serve as some kind of financial win.
A settlement that fits within the general rule includes compensation for medical expenses, pain and suffering directly related to the injuries, and lost wages that were caused by an inability to perform your job due to the injuries. For instance, if you broke your leg in a car crash and received a settlement covering your hospital bills and recovery, you typically won’t owe any taxes on the settlement amount.
IRC Section 104 and Tax-Free Components of Injury Compensation
Under IRC Section 104, settlements for physical injuries or sickness are expressly excluded from taxable income. It applies not only at the federal level but also at state levels in PA. Whether you went through a car wreck, got hurt from a slip and fall accident, or were injured by medical malpractice, settlements tied to your physical harm are usually tax-exempt.
Common forms of damages that qualify for tax-free treatment include reimbursement for medical bills, compensation for physical pain and suffering, and money awarded for loss of consortium. These types of damages are all going to be considered non-taxable because they are tied straight to your physical injury or ailment. However, you need to understand that tax-free status doesn’t apply automatically to all aspects of your settlement; it’s not a blanket statement.
Exceptions to Taxation Rules for Pennsylvania Injury Lawsuits
While most personal injury settlements don’t get hit with taxes, there are some exceptions to note. For instance, if your settlement includes money awarded solely for emotional distress without any accompanying physical injury, that amount is generally taxable. Emotional distress tied to physical injuries, however, remains non-taxable.
Punitive damages represent another exception. These are awarded not to compensate for your losses but to punish the at-fault party for particularly egregious behavior. While Pennsylvania does not typically tax punitive damages, they are taxable under federal law. Similarly, if your settlement includes interest income––for instance, interest accrued while the settlement amount was pending––that would be deemed a taxable portion.
Other taxable shares of a settlement might include compensation for business profits that were lost. If the injury you suffered caused a disruption to the operations of your business, then the settlement amount allocated to lost profits gets treated as those original profits in the sense that they are taxed. Furthermore, if your settlement includes wages like back or front pay, those amounts are also subject to employment taxes, even including Social Security and Medicare.
Understanding Tax Aspects of Structured Settlement Plans
In some cases, a personal injury settlement may be structured so you get periodic payments over time instead of a single lump sum. These arrangements are also called “structured settlements.” While tax rules stay the same in most situations, the portion of each payment linked to compensation for physical injury or sickness will be tax-free. However, any interest earned during the structured settlement plan will be subject to getting taxed.
Structured settlements can seem attractive to anyone who prefers steady streams of income to manage long-term incoming expenses. Either way, it is critical to understand how the tax implications of these arrangements might affect one’s overall financial picture.
Reduce Potential Taxes & Protect Your Settlement with Experienced PA Personal Injury Attorneys
When you get to the negotiation point with your personal injury settlement, it’s crucial to work side by side with your attorney on this part of the process, as you want to make sure that your settlement proceeds are appropriately allocated. Concrete allocation can make all the difference, especially in terms of maximizing tax-free portions of the settlement. You can explicitly categorize compensation for physical injuries in the settlement agreement, which helps to cushion that amount from any unnecessary tax scrutiny. Consulting with a tax pro can also give you additional insight into how and why the settlement will affect and act on your specific situation. They can also point out possible tax liabilities within the settlement and develop a minimization strategy. By working with both personal injury attorneys and tax experts, you can go into negotiations and structuring confidently.
Getting through that crazy and emotional aftermath following an accident can be overwhelming and even jarring, particularly when dealing with all the financial and legal aspects. Our trusted and skilled Pennsylvania personal injury lawyers at Cohen & Riechelson will fight tirelessly to deliver the settlement you deserve and keep your tax liability minimal. Serving all of Pennsylvania, including communities like Allentown, Bethlehem, Easton, Reading, Lancaster, and the Lehigh Valley, we know what it takes to get the compensation you are truly entitled to and how to minimize your tax burden when recovering a settlement. Contact an experienced Pennsylvania personal injury attorney on our team today at (215) 337-4915 to whip your settlement into shape and get started with a free review of your case.